Nonlinear Price Adjustment and Transaction Costs Between Global Stock Markets
Depository receipts (DRs) are instruments issued in a foreign market representing ownership in the underlying securities on the home stock market. DRs are practically the same as the underlying stocks and we can analyze price adjustment between the underlying stocks and DRs under the law of one price. The price differential would not disappear immediately due to the lack of perfect arbitrage if there exist considerable transaction costs. However, if the price differential exceeds some threshold level, it would converge into the threshold band. We treat this nonlinear price adjustment with the threshold autoregression model. The analysis of American depository receipts (ADRs) for Korean companies shows that transaction costs are significantly low between Korean and US stock markets. Especially, transaction costs for blue chips popular in the markets are smaller and price adjustment speeds for them are faster than those for unpopular companies. We analyze transaction costs across countries using indices consisting of ADR prices of each country's companies. We find that transaction costs for most of the countries are low but some countries that restrict foreign investors' free access to domestic stock markets show relatively high transaction costs
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